Why depositors rushed towards SBI during the Lehman crisis?

Barry Eichengreen and Poonam Gupta look at the case in this nice paper. (Well the authors say not to cite but since it is on the web, I really can’t help but link it.)

The Indian banking system was initially believed to be insulated from the global financial crisis owing to heavy public ownership and conservative management. To the surprise of observers,  however, Indian banks, private banks in particular, experienced a sharp increase in interbank  borrowing rates and deposit flight starting in mid-2008. In the case of the largest private bank, ICICI, deposits dropped by a tenth between June and December, as depositors shifted their money to government owned and operated banks. Public banks, led by the State Bank of India (SBI), meanwhile posted significantly faster deposit growth than the system as a whole (Figures 1 and 2).

We ask two sets of questions about this episode. First, which banks experienced the largest deposit withdrawals and why? Did the reallocation of deposits depend on the health of individual banks, as measured by publicly available indicators such as capital ratios, the quality of balance sheets, and lending growth prior to the crisis? Or was it a function of public versus private ownership pure and simple? Did deposits move to all public banks or only to select public financial institutions? Did public banks attract depositors because they enjoyed an explicit government guarantee, which was manifested by the public injection of bank capital where necessary, or because they enjoyed an implicit guarantee, reflecting the understanding that the government would not allow a public sector bank to fail?

What does analysis show? Yes, the depositors rushed to public sec banks and with them to SBI. Why? Main reason as per authors is implicit guarantee by govt:

Our analysis confirms that private banks indeed experienced slower deposit growth during  and after the crisis than before; and that this differential was most pronounced in FY 2009 and 2010. Public banks, in contrast, did not experience a similar slowdown in deposit growth, and the largest and oldest public bank, the SBI, experienced especially rapid growth in deposits.

We consider several explanations for the differential response, including the source of funding, i.e. whether banks that relied more on wholesale funding experienced a sharper deposit slowdown; credit growth prior to the crisis, which may have been an indication of low or declining lending standards; lower realized profitability, as a measure of bank health; bank size, as a proxy
for capacity to diversify and too big to fail; and explicit capital support by the government.

While there was some tendency for depositors to favour healthy banks with stable funding, our results suggest that the reallocation of deposits toward the SBI, in particular, cannot be explained by these factors alone. Nor can it be explained by explicit capital injections by the government. It seems that depositors were confident for other reasons that their deposits were safer with the SBI due to the government’s implicit guarantee of its liabilities, and that this dominated other considerations.

What are the solutions to address this?

The consequences of this behaviour are unlikely to be desirable. Insofar as investors flee to the SBI in the belief that it enjoys an implicit government guarantee, other banks will be destabilized. Other banks will have to hold more capital and maintain more liquidity to reassure depositors, which will work to their competitive disadvantage, and it is not clear in extreme circumstances that any level of capital and liquidity will suffice. In addition, the perception that public-sector banks, and larger public-sector banks especially, enjoy an implicit guarantee is a moral hazard that limits the incentive to enhance efficiency and may encourage excessive risk taking. 

Extending the state guarantee from public to private sector banks would address the first problem (flight from private banks) but aggravate the second (moral hazard). Blanket guarantees are also expensive for the state. Efforts to reduce the implicit guarantee enjoyed by public-sector banks, on the other hand, may not be credible and may have undesirable consequences for financial stability. The best ways of squaring the circle are by preventing institutions from becoming too large and connected to fail in the first place, requiring generation of the kind of data that enables the authorities to clearly distinguish cases of insolvency from cases of illiquidity, and setting up mechanisms for the orderly resolution of insolvent institutions (Demirguc-Kunt and Serven 2009).

Hmm..

Apart from this they also look whether PSBs continued to do well post crisis?

Our results show that the superior performance of public-sector banks did not last. Public banks, including the SBI, experienced slower deposit growth after 2010. In particular, banks that received capital injections in 2009 or 2010 had slower deposit growth. Public banks also experienced slower credit growth, lower returns, and higher provisioning. These results hold after controlling for the pace of credit growth during the crisis as well as for other bank-specific indicators such as bank size, profitability and provisioning prior to the crisis.

There was another paper which looked at similar case study but used different measure:

The only previous attempt to provide such an analysis of the effect of the crisis on the Indian banking system, of which we are aware, is Acharya, Agarwal and Kulkarni (2012). They show that while Indian financial firms were fairly resilient to the crisis, private banks experienced larger losses. Using a stock market-based measure of systemic risk, they estimate the systemic risk contributed by each Indian bank in the period preceding the crisis (January 2007 to December 2007) and compare it to realized returns during the crisis (January 2008 to February 2009). They find that public banks outperformed private banks during the crisis. They attribute this result to explicit government support of public-sector banks. Our approach differs in that we consider a  wider variety of bank characteristics and utilize information on not just the pre-crisis and crisis periods but also on the post-crisis recovery.

Hmm..

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